Cephalon-Cima Merger Gets OK

The Federal Trade Commission has alleviated the long-running angst of arbitragers and Internet chat-room investors by finally giving the OK to the merger of Cephalon ( CEPH) and Cima Labs ( Cima).

The agency endorsed the deal late Monday, and the 12-month-long saga apparently will be concluded in a few days.

The merger had achieved near-soap opera status. Here's a summary: Cima was approached with a stock swap offer from aaiPharma ( AAII) in early August 2003. Cima agreed, then Cephalon came along with a cash bid of $26 a share that was slightly better than aaiPharma's offer. But Cima rejected that last September.

In October, a mystery bidder entered the fray with a slightly higher bid. But in November, Cima agreed to a Cephalon cash bid of $34 a share. However, the Cephalon-Cima deal was held up by the FTC, which asked the companies in January for more information. While the FTC mulled the data, Cima investors stewed, as the stock dipped as low as $30 during the agency's deliberations.

The key sticking point was the potential anti-trust issue involving cancer-pain treatments marketed by Cephalon and under development by Cima. Cephalon sells Actiq, which looks like a lollipop, but is a treatment for sharp bouts of pain experienced by cancer patients. This pain is called breakthrough cancer pain, and the FTC said Cephalon's proprietary drug is the only such breakthrough cancer-pain product. The main ingredient in Actiq is a narcotic analgesic called fentanyl.

Cima has been working on a version of fentanyl called OraVescent fentanyl, a fast-dissolving pill that the FTC said would give Cephalon a monopoly in the breakthrough cancer-pain market and considerable power to discourage generic developers of Actiq.

The FTC says the U.S. breakthrough cancer-pain drug market is a $200-plus million a year market that is "growing rapidly." Cima has said that it expects to seek approval by the Food and Drug Administration of OraVescent fentanyl later this year or early next year. If all goes well, the drug could be available in late 2006. Cephalon also hopes to launch a sugar-free version of Actiq by mid-2005, contingent upon FDA approval.

The FTC could have ordered Cephalon to divest Actiq before acquiring Cima; but the agency, instead, allowed Cephalon to sign a licensing agreement with Barr Pharmaceuticals ( BRL). The deal will allow Barr to manufacture and sell a generic version of Actiq, effective no later than Feb. 3, 2007 and perhaps as early as Sept. 5, 2006. Under certain circumstances, the agreement allows Barr to make and market the sugar-free Actiq, too. The commission voted 3 to 1, with one commissioner recusing herself.

As a result, Cephalon, of West Chester, Pa., keeps a product that yielded $237.5 million in revenue last year; Cima's shareholders get their $34-a-share buyout; Barr gains access to a product with strong market potential; and aaiPharma shareholders get another reminder of what might have been.

Two analysts cut their ratings on Cephalon Tuesday, sending the stock down $4.87, or 10.2%, to $42.99 in late afternoon trading.

Donald B. Ellis, of Thomas Weisel partners, reduced his rating to peer perform from outperform. Ellis said the FTC's ruling could create "greater risk" to Cephalon's revenue from fentanyl products in late 2006, when Actiq could lose patent protection. He said the problem will occur because Cephalon's sales force won't have enough time to convince doctors and patients to switch from Actiq to the new OraVescent fentanyl. (Ellis doesn't own shares, but his firm is a market maker and expects to seek investment banking compensation or receive compensation in the next three months).

Morgan Stanley's Marc Goodman cut his rating to underweight from equal-weight, echoing Ellis' concerns that the FTC-brokered deal would make it difficult for Cephalon to promote and market OraVescent fentanyl vs. generic Actiq. Noting that OraVescent fentanyl is still in the final stages of clinical trials, he said that any delay in FDA approval of the drug -- or any problems in the final testing -- would cause a sharp setback for Cephalon. (He doesn't own shares; his firm has had an investment banking relationship).

Eden Prairie, Minn.-based Cima did pay aaiPharma a break-up fee of $11.5 million; but even that story may not be concluded. In its latest 10-Q filing, aaiPharma said it was "orally advised" by a Cima representative that Cima "wished to hold business discussions ... concerning a possible return of all or a portion of the $11.5 million termination fee. A possible recourse to litigation was discussed and aaiPharma intends to vigorously defend any such litigation if instituted."

Cephalon added that closing the deal with Cima would enable Cephalon to raise its full-year sales guidance by $15 million to a range of $915 million to $965 million and its third-quarter sales guidance by $5 million to a range of $250 million to $260 million. Third-quarter and full-year earnings-per-share guidance are unaffected.